The economic situation is getting tougher for all of us - and charities are no exception.

Central and local government funding for charitable organisations is being cut back as a result of the drive to reduce the deficit. Donations from members of the public are also coming under increasing pressure.

At exactly the same time that some traditional sources of funding are drying up, more and more people are looking to charities to provide desperately needed support and services.

It is because charities are determined to meet this need that many are increasingly looking for new and innovative ways to raise funds.

One idea that is increasingly being looked at is the issuing of charitable bonds which provide a form of long-term debt to expand their work.

How the bonds work

A charity or social enterprise may be able to issue bonds if it has a viable underlying source of revenue with which to repay the bondholders. These may include a chain of charity shops, payments by result for the delivery of a public service, or a long track record in raising funds from a large donor base.

As this form of finance is still emerging in the social sector, there are various types of bonds in existence.

The bond issued by Allia, for example, comprises an innovative investment - suitable for retail investors - to the housing association Places for People, which repays the loan with interest and additionally provides a grant to a charity. This bond allows individuals to invest as little as £100 per bond.

Paul Cheng says more charitable bonds may be available to the general public in the future

Another organisation, Investing For Good, arranges charity bonds and is currently assisting Scope, the disability charity, to become one of the first UK charities to enter the capital markets.

It is piloting a £20m bond programme operating similarly to corporate bond products and it is hoped that the programme will allow Scope to expand its income generating activities, such as its network of charity shops which generate long-term sustainable sources of income for its work with disabled people.

Triodos Bank is assisting the community interest company Bristol Together plan a bond issue worth £1.6m. The first £600,000 was bought by a charitable foundation and the second tranche of £1m will be sold to private individuals to attract Community Investment Tax Relief, which allows investors to reduce their tax bills by 5% a year for five years.

Risk

The guarantees offered to investors with charitable bonds vary, but are primarily based on the track record of the underlying investment, so it is important to understand this in order to gauge the level of investment risk.

Currently, with the exception of the Allia/Places for People bond, investment in charitable bonds is largely limited to charitable trusts and wealthy philanthropic investors.

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[Charitable bonds] could provide great opportunities for people wanting to invest their money for a return, while helping to make a real difference at the same time”

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It is hoped that in the future there will be a growing number of charitable bond products available with well-established track records, which will allow more widespread investment from the general public. This could be invested directly or through special investment products like pension funds.

One particularly interesting type of charitable bond is the Social Impact Bond (SIB) pioneered by Social Finance.

This contract is where the public sector pays the private sector to secure a substantial improvement in the way of life for a specific group, in order to reduce the public sector's costs in the long-run.

While the contract is ordinarily made with the private sector, the organisations that deliver the services on the ground are often charities or social enterprises.

Impact

Unlike traditional bonds, SIBs do not have a fixed rate of return as financial return depends on the achievement of specific social outcomes set at the start of the bond issue. The higher the social impact, the higher the return earned by the private sector.

Under a SIB, the charity sector organisation bears no financial risk as the repayment is commonly between the public and private sector. The public sector pays if, and only if, the intervention is successful.

One of the first SIBs was launched in 2010 by the St Giles Trust, a charity providing access to housing, training and jobs for ex-offenders.

This SIB has been designed to reduce reoffending among male prisoners leaving Peterborough prison who have served a sentence of less than 12 months. During the scheme, intensive support will be provided to 3,000 short-term prisoners over a six-year period, both inside prison and after release.

If this initiative reduces reoffending by 7.5%, or more, investors will receive a share of the long-term savings to the government.

If the SIB delivers a drop in reoffending beyond this threshold, investors will receive more money for the greater the success, up to a maximum of 13%.

However, if reoffending is not reduced by at least 7.5%, the investors will receive no recompense at all.

Charities have a long track record of innovation and charitable bonds are a sign of this.

Hopefully, they will go some way to plugging the gap left by the decline in some traditional sources of funding. At the same time they could provide great opportunities for people wanting to invest their money for a return, while helping to make a real difference at the same time.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Links to external sites are for information only and do not constitute endorsement. Always obtain independent, professional advice for your own particular situation.

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